Stock of the Day
Jan 26, 2000
Gartner Group: Investments Are About to Pay Off
Director of Online Research: Dave Sterman (1/26/00)
When it comes to the Internet, investors chase companies that are first to arrive on the scene. The effect, known as first-mover advantage, is said to help a company dominate its niche for decades to come.
Not always. Just ask the Gartner Group (NYSE:IT - news) . Founded in 1979, it had a virtual stranglehold on the information technology (IT) consulting market. Even as late as 1996, the company figured it controlled 83% of the sector.
But with the advent of the Internet, thousands of companies suddenly started to seek out help with their IT strategy. Instantly, a slew of competitors arrived on the scene.
Rivals such as Forrester Research (NASDAQ:FORR - news) , Jupiter Communications (NASDAQ:JPTR - news) , Intelliquest (NASDAQ:IQST - news) and Meta Group (NASDAQ:METG - news) took huge bites out of Gartner's business.
Traditional consulting firms, including the consulting arms of the Big Five accounting firms, entered the space, and technology servicers such as IBM Corp. (NYSE:IBM - news) and Electronic Data Systems (NYSE:EDS - news) also took business from Gartner.
It didn't make life easy.
Fortunately, Gartner was still able to boost revenue at a 30% clip from 1994 to 1998, thanks to surging demand for IT consulting in recent years, but the company's slice of the pie shrank.
Investors were oblivious to any looming problems, bidding the shares up to around $40 in the spring of 1998.
But as 1999 wore on, management had to regularly lower revenue growth expectations. By the end of the September fiscal year, growth slowed below 20%, down to just 8% in the company's core research business.
By the time, the company hit bottom last fall, its shares plunged to just $10. Since November, the stock has mounted a rally. On Tuesday, the shares slipped $0.50 to $16.13.
In early October, the board had seen enough, tossing out chief executive Bill Clifford and replacing him with 34-year old Michael Fleisher.
In short order, Fleisher has taken aggressive steps to right the ship. His efforts should start bearing fruit in the next few quarters.
Fleisher has been quick to move on Gartner Group's biggest weakness: A lack of focus on the emerging demand for e-commerce related consulting. Since his arrival, the company has added nearly two dozen analysts that have extensive e-commerce experience.
What's more, Fleisher has reinvigorated the sales staff by tightly correlating commissions with higher-margin consulting services.
Those moves have won the respect of Gartner's workforce, according to Deutsche Banc Alex. Brown's Peter Appert. “The new team appears to have a stuck a chord with the organization,” he notes.
Gartner, along with other IT consultants, suffered from tremendous turnover on its consultancy staff. The consulting firms have complained that they could be growing faster if they could attract and retain valuable personnel. In a bid to further stem defections, Fleisher has boosted the compensation for the company's consultants.
Fleisher also plans to spend more heavily to promote Gartner's strong brand franchise this year.
Although these moves will boost expenses – the company recently told analysts to boost their expense estimates by $50 million for 2000 – they will also have a positive impact on revenue.
As noted above, the tide may already be turning. On January 10, the company announced that revenue in the December quarter, the first of fiscal 2000, rose 19% sequentially to $222.9 million.
In the four quarters of fiscal 1999, revenue barley budged. Equally important, the company surpassed profit expectations for the first time in six quarters.
And though the stock has rebounded from its October lows, it is still more than 60% off of its 1998 highs. Taking advantage of the depressed stock price, the company bought back 2.7 million shares last quarter. In the prior quarter, the company bought back more than 10 million shares in a Dutch auction.
Thanks to the aforementioned heavy spending, analysts have lowered their earnings outlook to $0.80 a share this year, and around $0.90 in 2001. In fiscal 1999, the company earned $1.02 a share, but analysts have held off factoring any of Fleisher's revenue-building moves into their earnings estimates.
The Street is also assuming that operating margins, which have fallen 740 basis points from 24% to 16.6% over the last four quarters, would stay depressed. Even if Fleisher succeeds in boosting operating margins back up to only 19%, earnings would rise $0.23 above current estimates.
So let's assume that Gartner Group can earn $1.10 a share in the next fiscal year. At a recent $16.62, the shares trade at a P/E of just 15. In addition, the shares trade for less than two times projected 2001 sales of roughly $865 million.
In contrast, the competitors look downright expensive. Jupiter is only expected to post break-even results and trades for 6.4 times consensus sales estimates. Forrester trades for 38 times projected earnings and 4.8 times projected revenue.
In addition, more traditional technology consultants such as Whittman-Hart (NASDAQ:WHIT - news) and Sapient (NASDAQ:SAPE - news) sport significantly higher valuations as well.
Bottom Line:
After being burned for several quarters, Wall Street analysts are in wait-and-see mode regarding Gartner's prospects. But if you believe the long-term outlook for the company is bright, then you should take a closer look at the market share leader.
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